Directors need to be aware of the risks of taking dividends
In the last decade there has been a surge in small and medium sized businesses incorporating for tax reasons.
One of the reasons for doing so was to draw profits out and avoid National Insurance.
There is, however, a serious downside if the company gets into financial difficulties. If the company goes into liquidation it is very likely these dividends will have to be repaid. This is because dividends may only be paid out of distributable reserves (accumulated profits). The payment of a dividend not out of reserves is illegal and a breach of the Companies Act and there is no time limit on the Liquidator clawing this money back.
I have seen a number of cases recently where after going into liquidation, it becomes apparent that the directors were taking their effective salary as dividends. One of the first acts of the Liquidator is to write to the shareholders asking for this money back which comes as a complete surprise to the directors and there is no real defence.
The directors need to be aware of the potential risks of taking dividends when their company is having financial problems. They need to keep up to date with their annual accounts and management accounts and make sure that dividends are still appropriate. In some cases they may be better off taking salary rather than dividends because of these risks.